Wanted: chief firefighter

What the front-runner to lead the IMF could learn from the other candidates

CHRISTINE LAGARDE may be ahead by several lengths in the race to lead the IMF. But even if she wins as easily as now seems likely, the French finance minister would do well to consider the views of three of her rivals, who are central bankers as well as practitioners of the dismal science: Stanley Fischer of Israel, Agustín Carstens of Mexico and Grigori Marchenko of Kazakhstan. Political prowess is not to be sniffed at, nor is Ms Lagarde's record as a lawyer, but much of the firefighting job of the IMF involves tricky monetary and economic analysis.

Whoever prevails will inherit an outfit that has pledged €79 billion ($114 billion)—about two-thirds of its total lending commitments—to three euro-area countries that are struggling to repay their obligations and revive their economies without the freedom to devalue their currencies. Many economists think Greece, and perhaps Ireland and Portugal, will have to write down their debts. But Mr Fischer, who has reportedly been considering a bid for the job, said in 2002 that economists are far more willing for a country to default than the country's policymakers themselves. A number-two at the IMF between 1994 and 2001, he added that “it is the policymakers who will face the political consequences.”

Mr Fischer believes policymakers are “right to go far to avoid default”. But how far is too far? In January 2001 the IMF gave Argentina a big “last chance” loan to help it calm its creditors. It failed. In August 2001 they gave the country a second last chance. It also failed. Mr Fischer believed the August loan had a “non-negligible” chance of success—one worth taking to avoid the catastrophe that followed. But others disagree. Michael Mussa, a former research director at the IMF, says the August loan was “the greatest mistake the fund made in my ten years there.”

Mr Carstens, an openly declared candidate, knows first-hand what it means to restructure a country's debts. In 1990 Mexico swapped unpayable bank debt for so-called Brady bonds, worth about 35% less. Mr Carstens helped negotiate the deal. Like Mr Fischer, he believes such a restructuring should be “a very last resort”. Nonetheless, he thinks the 7-8 years of reschedulings, roll-overs and bail-outs that preceded Mexico's final Brady deal was too long for the country to wait. A better case to study, he suggests, is Uruguay's bond renegotiation in 2003, which was orderly, voluntary and took less than two months. It was not an easy way out: restructuring works only if accompanied by tough reforms to increase the country's ability to repay, Mr Carstens says.

One of the reasons Europe's policymakers worry about default is its impact on the banks that hold the debt. In the Asian financial crisis the IMF pushed governments to clean up their banking systems sooner rather than later. The fund's critics say this made the recession worse. Repairs take time. But that is no reason for delay, Mr Fischer has argued, citing the instructions that Hubert Lyautey, a French general, gave to his gardener: if a tree takes 150 years to mature, that's all the more reason to plant it as soon as possible.

No one has pruned the financial garden as aggressively as Mr Marchenko, the candidate backed by Russia. After Kazakhstan won its independence in 1991, financial institutions mushroomed, as state-owned enterprises set up banks to get cheap central-bank credit. From 1994 onwards, the regulators weeded out scores of banks. Anders Aslund of the Peterson Institute for International Economics in Washington, DC, says that Mr Marchenko “prides himself on having closed 80 banks”. He is “as tough as they come”.

What about the candidates' views on other issues facing the fund? In the late 1990s emerging economies suffered from capital outflows and plunging currencies. Today they fret about excessive inflows and strengthening currencies. Even after the Asian financial crisis Mr Fischer still believed that “orderly” capital-account liberalisation should be made one of the IMF's core purposes. But he recognises that controls on inflows, though inelegant, may be necessary at times. Indeed in January he himself imposed a reserve requirement on Israeli banks entering into foreign-exchange derivative transactions with non-residents.

Burning issues

In April the IMF released a “framework” to guide countries' thinking on such measures. Mr Carstens regrets it was not “precise” in distinguishing between capital flows prompted by external events and inflows attracted by a country's own brighter prospects. Modest controls may be legitimate in the first case, but not the second, he says.

One external factor influencing capital movements may be American monetary policy. The Fed's aggressive easing has depressed yields, encouraging capital to flow elsewhere. In principle, countries can insulate themselves from the Fed's actions by allowing their currencies to float upwards against the dollar. But in practice, countries are reluctant to do so, fearful that an excessively strong currency will hurt their exporters.

Reforming an international monetary system that relies so heavily on the greenback is one of the ambitions of Ms Lagarde's government, which now chairs the G20 group of big economies. The French have suggested a greater role for the IMF's own synthetic reserve asset, the Special Drawing Right (SDR). The value of the SDR is based on a basket of currencies (the dollar, euro, yen and pound) that might expand one day to include the yuan.

Does the SDR have a role to play in rebalancing the world economy? “The quick answer is no,” says Mr Carstens. It is, after all, only a bundle of national currencies—no more than the sum of its parts. The longer answer, he says, is that it might have some indirect benefits. If the Chinese want the yuan included in the SDR, they will probably have to liberalise their capital account first. That would be welcome in itself—as a shrewd lawyer would no doubt be as quick to point out as a sharp economist.